Analysis: Shareholder adviser ISS tightens screws on directors

By Ross Kerber

8 Min Read

(Reuters) - As thousands of U.S. companies prepare for their annual meetings over the coming months, the influential shareholder adviser ISS has signaled it is going to put directors on a shorter leash.

ISS, the largest adviser on shareholder balloting by institutional investors, has adopted a new policy that from 2014 will make it more likely to recommend shareholders oppose individual directors in board elections if a company ignores non-binding votes for governance changes in the previous year.

Before, ISS gave directors at least two years to respond to shareholder support, based on a majority of votes cast, for reforms such as holding annual elections for all directors or abandoning "poison pill" takeover defenses.

And its recommendations hold a lot of sway with institutional shareholders. A study of thousands of corporate elections published by the Journal of Finance in 2009 found that a negative recommendation from ISS reduced support for directors by 19 percent.

While the new ISS policy is not in force this year, some governance experts believe it will begin to have an influence on boards and prompt them to more readily respond to shareholder votes for reform.

In the past, companies dealing with the results of shareholder resolutions they don't like have found ways to head off open revolts against directors by making only partial changes to satisfy a few big shareholders.

Others, such as Vornado Realty Trust (VNO.N), have set aside votes altogether. It has not acted, at least through last May on resolutions calling for its directors to be elected by majorities of votes cast, even though the resolutions received a majority of votes cast in each of the past six years.

A Vornado spokesman declined to comment. It is possible that Vornado may have changed its policy with little public notice to date.

Vornado had argued the change could give too much influence to advisory firms and activist shareholders.

While cases like Vornado are rare nowadays, other companies also have been persistent in ignoring or stalling their response to non-binding votes, according to data from the Council of Institutional Investors. It counted ten proposals at Russell 3000 companies that have not been implemented for at least two years despite getting a majority of votes cast each time. The new policy will make that harder, said ISS Special Counsel Patrick McGurn.

For instance, if the policy were in place for 2013, online video company Netflix Inc (NFLX.O) and Nasdaq OMX Group Inc (NDAQ.O) may have faced ISS recommendations for shareholders to vote against the companies' candidates for the board.

Netflix has yet to disclose action on a vote last year that urged requiring the annual election of all directors, which was supported by 75 percent of the votes cast, even though Netflix had argued its current structure was best for its long-term interests. A Netflix spokesman declined to comment on whether it will implement the policy.

Another test could come at exchange operator Nasdaq, which last year faced an activist shareholder's proposal to make it easier to call special meetings, a tool used by individual shareholders seeking to pressure boards.

Nasdaq had argued the proposal could be disruptive, but it won just over 50 percent of votes cast. A Nasdaq spokesman, Joseph Christinat, declined to discuss if the company will make the change. "We listen to and take seriously all the feedback from our shareholders," he said.

ISS has already targeted Borje Ekholm, who was named Nasdaq chairman in December. He won only 70 percent of votes cast last in the board elections last May after ISS recommended against him because he had multiple other business commitments. ISS recommended votes "for" each of Nasdaq's other ten directors, each of whom won 98 percent or more of votes cast. Nasdaq said the other jobs made Ekholm more suited for his Board role.

Even popular directors watch their polls and are more likely 'to follow shareholder wishes on governance matters if their vote tallies decline, said Drexel University finance professor and co-author of the Journal of Finance-published study, Ralph Walkling. "These votes have teeth," he said.

Some big investors have embraced the policy change, saying that turning up the heat will make companies more accountable to shareholders.

"If a majority of shareholders speak, we believe boards should take that as a pretty serious mandate," said T. Rowe Price Group (TROW.O) governance analyst Donna Anderson. T. Rowe is the second-largest institutional shareholder of online retailer Amazon.com (AMZN.O) and the fourth-largest holder of search giant Google Inc (GOOG.O), among other major holdings.

Not everyone is a fan. Several large companies, including FedEx (FDX.N) and Pfizer (PFE.N), and the U.S. Chamber of Commerce, have blasted the ISS policy as over-reaching. Among their concerns: the rule may reduce the leeway for boards to work things out with large shareholders.

Kenneth Bertsch, president of the Society of Corporate Secretaries and Governance Professionals, said directors may also be worried that ISS will recommend against their re-election without regard to the merits of a shareholder proposal.

"This...will result in boards' hands being forced to implement policies that they may not believe is in the company's best interest," said Tom Quaadman, who oversees the Chamber of Commerce's efforts on financial markets, via e-mail.

PROCEDURAL SKIRMISHES

The ISS move goes to the heart of a long struggle between shareholders and company leaders over who has corporate power.

Lately the noisiest fights have been about governance structure, such as whether to split the CEO and chairman jobs, and executive compensation.

Pension funds and big asset managers like BlackRock Inc (BLK.N) and Fidelity Investments are paying more attention to governance issues - and sometimes switching sides to vote against management. For instance, Fidelity's $85 billion Contrafund (FCNTX.O) - one of the most widely held in 401(k) retirement plans - switched sides and voted against the $15 million pay package of Citigroup Inc's then-CEO Vikram Pandit last April.

Advising clients in these areas has brought new business to ISS - a unit of MSCI Inc (MSCI.N) - and its closely held rival Glass, Lewis & Co. ISS' McGurn said the new policy merely follows the wishes of its clients - large asset managers and institutional investors - by pressing for faster responsiveness from boards.

The ISS change could mean that more directors get a rough ride.

ISS itself urged votes "for" directors roughly 97 percent of the time among the S&P 500 in 2012. Among Russell 3000 companies ISS counted just 61 director nominees who failed to get a majority support from shareholders.

McGurn said that overall ISS hopes the move only will boost corporate responsiveness to shareholders. "We want to see a response, we want to see some engagement," he said.